How Will The State Income Tax Work?

August 24, 1991|By BILL KEVENEY; Courant Staff Writer

This is the first of an occasional question-and-answer series about changes in the state's tax system. Many of the questions were provided by Courant readers. Most of the answers in today's installment were provided by Richard D. Nicholson, legal director for the state Department of Revenue Services. The new income tax is based on a taxpayer's Connecticut adjusted gross income. What is that? Connecticut adjusted gross income is similar to federal adjusted gross income, which appears federal tax returns.

As with federal adjusted gross income, the Connecticut version will consist of wages and investment income. It will include income from unemployment compensation, pensions and annuities, and income from IRA and Keogh plans. The portion of Social Security payments that is considered taxable income by the federal government also will be considered taxable by the state. Worker's compensation is excluded from adjusted gross income.

Connecticut, like the federal government, will allow a few deductions in determining adjusted gross income, such as payments to self-employed health insurance plans or Keogh retirement plans.

There will be two primary differences between the federal and state definitions of adjusted gross income. Connecticut will tax interest earned on bonds issued by other states and by out-of-state municipalities, which are not taxed by the federal government. Connecticut will not tax federal securities, such as Treasury bills.

How will people who work in Connecticut but live in other states be taxed? How will Connecticut residents who work out of state be affected? In both cases, it is unlikely taxpayers will pay more than they do now. Taxpayers will receive credit for the state income tax they pay to Connecticut or to the three surrounding states, all of which have higher rates than Connecticut.

A person who resides in Massachusetts but works in Connecticut already pays an income tax to Massachusetts for wages earned here. As of October, Connecticut will collect its percentage of the tax.

In the case of a Connecticut resident working in New York, that person now pays a New York state income tax (and a New York City income tax if they work there). The worker will receive a credit for that tax against the Connecticut income tax obligation.

When will the income tax start? The income tax takes effect

Sept. 1, but employers will not begin withholding taxes from workers' paychecks until Oct. 1. They will be withholding four months of taxes during the 3-month period.

Since only four months -- one-third of the year -- is covered, the tax will effectively be 1.5 percent for the entire year. That is one-third of the 4.5 percent rate that was adopted. The full 4.5 percent rate will be applied to all income starting in 1992.

Is there anything to soften the tax blow? Yes. The new plan allows low- and moderate-income taxpayers to exempt part their income -- up to $24,000 for a family. It also includes a tax credit that will allow many taxpayers to reduce their tax payment from between 10 percent and 75 percent.

How will investment income -- capital gains, dividends and interest -- be taxed in 1991, which is now a hybrid tax year? Investment income will be taxed at two levels -- one for the rates up to the end of August, and one covering the new rates that will take effect Sept. 1.

The current rate for capital gains is 7 percent, and the new rate will be 4.5 percent. For 1991, the state will charge roughly two-thirds of the existing rate, or 4.75 percent, and one third of the new rate, or 1.5 percent, for a combined rate of 6.25 percent.

Similarly, the current rate for interest and dividend income ranges from 1 percent to 14 percent, depending on an individual's income. The hybrid rate for 1991 will consist of roughly two-thirds of those rates, or between 0.75 percent and 9.5 percent, plus 1.5 percent, or one-third of the annual 4.5 percent rate.

What is the gift tax? As of Sept. 1, Connecticut will apply a graduated tax of 1 percent to 6 percent to gifts worth $10,000 or more.